Trading/investing – a game of probability?

When I mention trading is a game of probability, no one seems to disagree. However when I say investment is also a game of probability, not many seems to be convinced. Dividend, growth and value investors may speak with conviction that they are buying into a business, not exchanging papers and they are not speculating for a quick bucks etc. yup that’s true and while I do agree that buying a wonderful business at fair price is a good investment mantra, I still look at it from a different angle – a game of probability. Do allow me to explain.

If you are a value investor, you will study and pick the business with strong balance sheet, solid management team, great long term growth prospect and most importantly undervalue or at least fair price company (There are numerous way to value a company, the most prominent should be using discounted cash flow method or relative method). You will then wait for the share price to move up to the intrinsic value/fundamental value. You will decide to sell the stock and move on to hunt for the next value stock when the stock price becomes expensive (high P/E). All the steps that are mentioned here require effort and the more you understand the business (reading annual reports) the more comfortable you are to buy and hold the stock. What you have done here is the hardwork to increase the probably of making a good profit in this stock/business. Does it guarantee a success? Not 100%. That’s the reason we need to learn money management, portfolio allocation etc and all these further improve the probability of success. Some investor guru suggest to pick the dividend stock, what is the rational of doing so if we could pick a value stock which give us few hundred percents of return? Do we still bother the dividend in that sense? The problem here again is that we don’t know and never know if the stock/business that we have picked will really spike up. If we are wrong, the dividend can at least reduce the cost base. When the cost base is lower, the chances of the success will be higher. We are still talking about the probability of success over here.

If you are a technical trader or a chartist, you may look at the candlestick chart and some other indicators to craft your trading plan. You determine the entry price, profit target and stop loss. You calculate the risk reward ratio. You ensure that you are comfortable to stomach the risk/loss if market goes against you. So what are you trying to do here? You are trying to do all it takes to increase the odd of winning. You are dealing with a game of probability in which you limit the losses while letting the profit run to enable a higher chance of success in trading the market.

In summary, regardless which approach we take, we are dealing with probabilities. Hence, we should only trade or invest if and only if the chances of success is high. Cheers!